Since 2015 the Fair Trading Act (FTA) has prohibited the use of unfair contract terms (UCT) in standard form consumer contracts. From 16 August 2022, the prohibition on UCTs has been extended to small trade contracts.
Will this affect construction contracts in New Zealand? In this article, we discuss this, and potential unfair terms in construction contracts.
Prohibition on UCTs
The UCT regime applies to standard form contracts, which are contracts comprised of terms not subject to effective negotiation between the parties – in other words “take it or leave it” contracts. There is no prescriptive list of what constitutes a standard form contract, but the following factors are taken into account:
- whether one of the parties had all or most of the bargaining power in the transaction;
- whether the contract was prepared by one party before any discussion took place about the transaction;
- whether a party was, in effect, required to accept or reject the terms of the contract in the form in which they were presented;
- the extent to which the parties have an effective opportunity to negotiate the terms of the contract; and
- the extent to which the terms of the contract take into account the specific characteristics of any party to it.
Importantly, when the Commerce Commission alleges a contract is a standard form contract, the contract is presumed to be so.
Changes to the UCT regime to apply to small business-business contracts
The prohibition on UCTs is now applicable to small trade contracts. A contract is a small trade contract if:
- each party is engaged in trade;
- it is not a consumer contract; and
- it does not comprise or form part of a trading relationship that exceeds an annual value threshold of $250,000 (including GST) when the trading relationship first arises.
When will a term be declared unfair?
The Court may declare a term to be unfair if it meets all three of the following requirements.
- The term would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
- The term is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by it; and
- The term would cause detriment (whether financial or otherwise) to a party if it were applied, enforced or relied on.
In making this determination, the Court may consider any matter it thinks relevant, but must take into account the contract as a whole and the extent to which the term is transparent. The FTA also includes a list of examples of terms that may be unfair terms. These examples primarily involve allowing one party to do something and not the other party – i.e. avoiding/ limiting performance, terminating the contract, varying the terms or penalty clauses.
Despite this, some terms – “exempt terms” – cannot be declared unfair. These are terms that define the main subject matter of the contract or sets the upfront price payable under the contract.
Will the new UCT regime apply to standard form construction contracts?
The monetary threshold for a small trade contract means that on this test alone many construction contracts will not be captured by the UCT regime. However, small value standard form construction contracts – for example, a standard form contract used by a contractor for small works subcontracts with no opportunity for negotiation of it – may potentially be captured. While the UCT regime is yet to be tested in the construction context, there are a number of terms which are commonly found in construction contracts that may be deemed to be unfair. This will depend on the exact nature of the clause, and the particular facts and parties, but some possible examples are below.
Unilateral Variation of essential terms of scope
Clauses that give only one party the right to vary the terms of the contract are arguably at risk of being declared unfair. This is more likely if the term allows one party to unilaterally vary the scope of work, service or price without penalty.
Extreme limitation of liability
Parties to a contract frequently seek to exclude or limit the liabilities and remedies which would otherwise arise through a breach of contract. There is nothing inherently objectionable about limitation clauses where the parties have equal bargaining power and the contract is a genuine deal struck between them. Where limitation clauses could be at risk of being unfair under the UCT regime is where the parties do not have equal bargaining power, there was no negotiation as to the allocation of risks and the limitation clause is broad, extreme and one-sided.
Terms excluding remedies for default
Similar to a limitation clause, there may be an attempt to limit the type or extent of remedies recoverable by an innocent party or exclude a method of recovering remedies. These types of terms which exclude or significantly limit claims by one party are at risk of being deemed unfair under the UCT regime.
Indemnity clauses transferring liability to a small business regardless of fault
Clauses that transfer liability to one party for circumstance beyond its control may arguably be unfair under the UCT regime. Some examples would include warranties in relation to work performed by others (i.e., pre-existing work, design prepared by others) or broad, unqualified indemnities (i.e., an indemnity for any losses suffered in connection with the work regardless of the cause)
Consequences of an unfair term
The Commerce Commission is responsible for enforcing the UCT regime, and may seek a declaration from the District or High Court that a term is unfair.
If a Court makes a declaration that a term is unfair, from that time the business must not include the term (unless done in a way that complies with the Court’s decision) or attempt to apply, enforce or rely on the unfair term. If a business continues to use a term that has been declared as unfair, it may face:
- in the case of an individual, a fine not exceeding $200,000; and in the case of a body corporate, a fine not exceeding $600,000;
- an injunction restraining the person from including, applying, enforcing, or relying on the term; and/or
- orders directing a refund or payment of damages.
A declaration that a term is unfair does not end the contract as a whole and all other terms of the contract will continue to bind the parties.
The full impact of the UCT regime remains to be seen, but in the meantime those in the construction industry would be wise to consider whether any of their contracts could be caught by the regime.
This article was authored by Jessie Kang, a solicitor in our Construction and Infrastructure team.
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